What You Need to Know About Living Wills

What Is a Living Will?

A living will is a document from a financial firm that describes how it would go through bankruptcy without causing a broader economic panic or needing a bailout from taxpayers. The largest U.S. banks have filed several versions of them since the 2010 Dodd-Frank law, which ​required living wills from financial firms ​that were judged to pose a potential risk to the broader economy. The documents are also known as resolution plans. “Resolution” is regulatory parlance for dealing with a failing financial firm. Living wills are separate from other regulatory requirements, such as annual “stress tests” that measure whether could banks survive a severe recession.

Why Are Living Wills Important?

For banks and their investors, passing regulatory muster on living wills is a necessity because Dodd-Frank gives the Federal Reserve and the Federal Deposit Insurance Corp. significant power to deal with firms that don’t, including possibly breaking them apart. The living wills are also designed to prevent a repeat of the 2008 bailouts. If firms don’t have strategies for failing without taxpayer help, it is possible the government would have to step in and save them to prevent a broader calamity.

Who Has to File Living Wills?

Dodd-Frank says all banks with more than $50 billion in assets must file living wills, as well as any financial firm designated as a “systemically important financial institution.” Other banks also have to file them under other regulatory requirements. Different groups of banks file living wills and receive feedback at different times. The Fed and the FDIC on Wednesday announced their judgment on the most recent living wills filed by the eight U.S. banks considered most important to the system.

What Is the Legal Standard for Passing Living Wills?

Dodd-Frank says that regulatory sanctions apply only when banks have living wills that are either not credible or would not facilitate an orderly bankruptcy. For any sanctions to take effect, both the Fed and the FDIC must agree that firms have failed to meet that standard.

What Happens if Regulators Reject a Living Will?

Dodd-Frank says that when regulators make that determination, they must give firms a chance to fix deficiencies and resubmit their living wills. If those new plans again fail, in regulators’ view, to demonstrate that the banks could credibly go through an orderly bankruptcy, regulators could impose further sanctions such as higher capital requirements or restrictions on growth or activities. Two years after the initial sanctions are imposed, regulators have the power to force firms to divest assets or operations that are deemed obstacles to an orderly bankruptcy.

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